Wall street’s need for a return to character

Not long ago, US President Barack Obama unveiled his plan to resurrect the financial sector, including the provision of expanded powers for the Federal Reserve, a stronger focus on systemic risks and higher capital requirements. While one hopes that increased legislation will fix some of the problems of the past year, there remains too little effort to alter the basic shortcomings in moral character which lay at the heart of the banking crisis.

Since the collapse of Bear Stearns, perhaps no one has been reviled as much as senior management of financial services firms. Chief executives of these companies have been accused of wanton and callous disregard for the economic welfare of the people. Governments in many countries have stepped in to regulate pay and other incentives.

Was it always like this? Does the mere presence of skewed and economically unjustified incentives automatically make people prone to forget their value system? Is there another way to run this critical sector of the economy? Some examination of economic history would suggest that leaders in this sector were once different.

In 1931, Goldman Sachs, then not a particularly large firm, suffered substantial losses through shares it had sold in a company called Goldman Sachs Trading Corp. Although many lay investors did lose money through the various schemes Goldman had floated, the reaction from the firm’s leadership was of penitence. Owner Walter Sachs and his partners agreed to bail out several others including some junior employees, at a cost of at least $200,000 (Rs97 lakh) per senior partner.

Sidney Weinberg, a junior porter with Goldman Sachs when the above scandal broke, went on to become a name to reckon with in the world of high finance and led the firm until the 1960s. In 1958, at the peak of his success following the successful issues of Ford Motor Co. and Sears, Roebuck and Co. papers, Weinberg was candid enough to advise the public against investing in the market as it had overheated, although doing so may have burst a bubble from which his company may have benefited. Similar candour was clearly missing in his successors.

In 1969 and 1970 , shortly after Weinberg left Goldman Sachs, the company sold papers in the Penn Central Transportation Co. railroad. Penn Central floundered in 1970. In an incident eerily similar to what happened with Lehman Brothers Holdings Inc. last year, Goldman Sachs had expected that the government of the time would come to the rescue of the famous railroad, but the government allowed the company to sink into bankruptcy. That time, at the instance of Gus Levy, the new head of Goldman Sachs, the firm tried to compensate clients in some small part, although in doing so, many senior partners had to incur significant losses.

Goldman Sachs was not alone in attempting to uphold old-fashioned values. Recently, the world lost Albert Gordon, the long-time president of Kidder, Peabody and Co. Having built Kidder Peabody for over five decades from the 1930s, Gordon—who represented the values of a different age—sold his own shares back to employees at a discount, travelled coach class—again differently from the liberal use of private jets by the current crop of leaders—and used to take the subway to work. That unbridled self-aggrandizement was not the norm on Wall Street seems clear even from such anecdotal evidence. All these individuals acted in ways which are at significant variance with the sense of entitlement we saw last year, when individuals tried to justify the indefensible payouts in some of the largest banks and insurance companies.

In 1895, in a complete reversal of what is happening today, J.P. Morgan helped European financiers fund large deficits in the US treasury through a bond that he and his colleagues issued. In 1907, Morgan again averted national financial disaster when many institutions in the US faced bankruptcy due to a loss of market liquidity and the absence of a lender of last resort. Morgan and his friends pledged large sums of their money to avoid a run on the banks.

None of these individuals was a monastic saint. They were successful to the point of being legends. The memory of Morgan and Weinberg shines beyond the veil of darkness drawn across the profession by their successors.

Clearly, the old guard represented a different type of financial services leader. There was always a preparedness to think of the collective over the individual, the country before self and Main Street before Wall Street. Faced with moral choices, they did not indulge in the sophistry of their succeeding cohorts.

Several leaders in this sector appear to be groping their way through this crisis. They may want to recall the legacy of their professional predecessors. They may find the inspiration in them that is a simpler solution to today’s problems than yet another round of high-leverage and distorted incentives.

Govind Sankaranarayanan is CFO, Tata Capital Ltd. He writes on issues related to governance. The views expressed in this column are his own. Write to him at ruleofthumb@livemint.com